Marin County and California Insurance and Annuity Attorney: Taxes on Surrenders

ATTORNEY NEWSLETTER

Life Insurance Surrenders: The Tax Consequences

Surrendering Life Insurance

Whenever an insurance agent starts talking about surrendering or “changing” or “replacing” your life insurance policy, remember one important thing if nothing else: there will be tax consequences. We here at Evans Law Firm are not tax attorneys but as experienced insurance and annuity attorneys we see policy surrenders and/or replacements every day. Quite often the results are disastrous, especially when it comes to surrender charges and taxes. Even if your policy is so old that there are no longer any surrender penalties, remember that is not the whole story. Many Americans surrender, replace or sell old policies and then find themselves with large, unexpected tax bills. Always discuss any policy change or surrender or replacement with your tax expert. If you have already suffered a tax loss or surrender penalty on a surrender and/or replacement, call Evans Law Firm today at 415-441-8669 and we can help. You may well have been the victim of fraud or financial elder abuse. We represent clients in the State of California.

The Tax Implications

The “gains” or appreciation in value of life insurance are not recognized for tax purposes until you surrender or sell a policy. When you surrender, the amount you receive is ordinary income to the extent it exceeds premiums paid. While the gains in your policy accrue tax free as long as the policy is in force, at surrender those gains will be taxed at ordinary income rates, not lower capital gains rates. If your surrender is part of an exchange for a like kind policy it may qualify as a tax-free exchange, known as a “1035 exchange.” But be extremely careful here and make sure you and your tax preparer go over the proposal beforehand. Then if you’re still determined to go forward, you and your preparer should track any 1035 exchange from start to finish. The IRS has very stringent rules governing these exchanges and the slightest mistake or oversight (by you or the agent) makes the exchange fully taxable at ordinary rates.

Bottom Line

The severity of the tax problems is an added red flag here. There are other pitfalls. Replacing existing policies is also known as “churning” those policies. This is just like a stock broker who churns clients’ accounts – repeatedly buying and selling shares for commissions. Some insurance agents churn their clients’ policies the same way even though the churn makes no economic sense. We at Evans Law Firm see incidents of this every day. We also see cases where agents deliberately ignore tax rules and consequences altogether and conceal your churn (known as a concealed replacement) in the interest of a big sales commission. Always consult a professional/third party when considering a policy replacement, and always run any policy surrender, exchange, sale, or replacement past your tax advisor before signing anything.

Contact Us

If you or a loved one has suffered a tax, surrender penalty or other loss on a whole life insurance policy or annuity in Marin County, or in any California county, contact the Evans Law Firm life insurance and annuity attorneys at (415) 441-8669, or by email at info@evanslaw.com. Our attorneys have experience with complex financial contracts and large insurance companies. We can help guide your case through a FINRA arbitration, jury trial or toward an equitable settlement. We handle cases involving physical and financial elder abuse, qui tam and whistleblower law, nursing home abuse, whole life insurance and universal life insurance, and indexed, variable, and fixed annuities.